November 16, 2000
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Adventures in Valuation #2
Whitney Tilson wrote a Fool on the Hill article about Valuation last week, and followed with another article yesterday. Those who are in a hurry to learn about Value Investing should give their full attention to Whitney, as I'm going to be examining the topic in a much more leisurely and circuitous way. Besides, Whitney actually knows what he is talking about, while I only claim to be an interested learner. I realize that my loopy cast of mind is going to be frustrating for some people, and I encourage everyone who is interested in the subject to consult Whitney's contributions to the topic. I will be too.
You will also do well to study the writings of Warren Buffett, which are also readily available. There is a great deal of this that I have not read, but it comes so highly recommended by from people I respect that I list it here:
I took a lot of economics classes when I was in college. The first few were degree requirements, but I found that I was interested in the subject and took a few more courses than necessary. The first lecture of my very first econ class began with the professor walking to the front of the class and writing, in large, formidable letters, the word, "SCARCITY" on the blackboard. Scarcity, he said, is the basic economic problem. I expect that most beginning econ classes in most universities begin in more or less the same way, with this slap in the face from the bleak and destitute world in which we are all fated to live. Serious economics, we are told, begins with an acceptance of the harsh realities of life (note how the word "reality" is so reflexively modified with the word "harsh"), and with an understanding of the desperation and injustice that is our natural wretched condition. Economics is ruthless business, Fools. Thomas Malthus and all that. The sooner you bring yourself to accept our hopelessness, the better.
By now you are probably already getting an inkling as to why Economics is regarded as The Dismal Science. Scarcity is determined to be the source of all value in economic matters, the key concept behind all our approaches of defining what an object or a service or some other process is worth, at least within an economic or financial context. It is not accidental that this is the case. Supply and Demand theory, the foundation of modern Capitalist thinking, only works if the "supply" part of the function is a finite number. When supply is infinite, demand is irrelevant. Where there is no scarcity, there is, in effect, no Economy. Economics begins in scarcity, and without it, economics has no meaning.
Our experiences with money have trained us to think within this scarcity frame, and it has served us well. Our social preoccupation with scarcity has made our economy remarkably efficient. It has prompted innovation far beyond anything any reasonable person should have expected even a few short decades ago. We all enjoy a great many benefits thanks to that approach to life, although it does not come without its own costs. The downside of the scarcity frame is that it produces a lot of desperate striving and a focus on matters that ultimately, are unimportant � or perhaps "unimportant" is too strong a word, but to say that matters of money are trivial compared to the real pleasures and rewards of life is an idea so commonplace that it is often overlooked. A life spent in the pursuit of money, while disregarding all other value, is a life wasted, as any honest reading of anything Charles Dickens ever wrote would quickly demonstrate.
As it happens, I do not live in a world of scarcity. I live in a world of abundance. Everything I could reasonably want in life is available to me in enormous, astounding quantities. Food is everywhere and cheap. I don't think I spend more than a few hundred dollars for clothing every year. Shelter is my most onerous expense, but that is only because I have chosen to live in a high-rent locale. Air and water are virtually free. Entertainment costs me nothing unless I am feeling extravagant � the highest entertainment there is is good conversation with people who interest me, and that costs nothing. Good friends and interesting company are abundant, as surely as any friendship that would need to be purchased wouldn't be worth having.
I am not a wealthy man. I have, throughout my life, studiously avoided gainful employment (God bless The Motley Fool). I was well into my 30s before I ever earned more than $10,000 in a single calendar year. And yet, I've never missed a meal in my life, I never lacked for an education (makeshift as mine has been, cobbled together more from my own efforts than anything offered through any formal institution), and somehow I managed to find myself frequently in the respectful company of some extremely wealthy and influential people over the course of my life. My life has been remarkably rewarding, and where I have found poverty � and there has been enough of that � it was my own failure to understand the opportunities around me that kept me from enjoying them. But not having money taught me a great deal about the real nature of value, enough to know that the real value of life is not measured in dollars and cents but in some coin not yet invented.
I realize that I am trying the patience of many readers who will accuse me of being artfully dense on this consideration of value. There is a difference, they will say, between economic value and the sort of value we mean when we mouth the old clich� that the best things in life are free. But that is sort of the point. If you are expecting money to do things for you that it cannot, then you are likely to take risks with your investments that are unrealistic. If you expect money to make life more wondrous or exciting, you are apt to be disappointed. You can find wonder and excitement without ever spending a dime, and if you are a dull person, your life can be just as drab on Park Avenue as it would be in public housing.
For all of Warren Buffett's billions, the Dilly Bar he buys and eats today won't taste any better to him than the one *I* buy and eat does to me. And the cost of that Dilly Bar is virtually as trivial to me as it is to him. Donald Trump may harbor a secret desire to run a marathon, but regardless of what he is willing to pay for that experience, he's certainly not going to be able to buy the privilege. He will have to earn that right, exactly as anybody else would. I don't know what the per capita income in Kenya is, but I expect that Kenya is always going to turn out more world-class runners than Atlantic City ever will. Meaning that whatever might be involved in creating great athletes, it seems that money has very little to do with it.
What's money worth? Whatever its value, it does not encompass all.
Music doesn't sound any better just because you have money in the bank. Great works of art do not become any more impressive simply because you have a fistful of Berkshire Hathaway A shares in a vault somewhere, nor will your ability to create them be necessarily enhanced because you happen to know where your next meal is coming from. People do not become more virtuous or more entitled to happiness � or any more likely to achieve it � because they have an ATM card that will spew an endless stream of cash. And those who are impressed by such things, who do imagine themselves to be happier because of their money, are perhaps missing the real values that life offers. This is not for a second to deny the profound contribution that a healthy respect for industriousness and frugality, and all the rest of the sound economic virtues we rightfully admire, can make in your own life and for the world at large. I mean simply to draw a distinction between the things that commerce can bring you, and the real value of life swirling about you at every conscious moment. You need only look up and acknowledge the riches you already have in your hands.
My point is that our habitual deference to the concept of scarcity does not in any objective way represent the real authenticity or the legitimacy of your life. To say that value is determined by scarcity is simply an assumption, useful in certain ways, but nothing absolute or definitive. It is only � and I mean only an idea that has been adopted intellectually in order to serve a defined purpose. I am absolutely convinced that, whatever honor and prestige we grant to people in the higher income brackets, 90% of what money can bring an individual can be had in the first $25,000 per year. The rest is pleasant, rewarding, and remarkably unimportant. The degree to which you have to struggle to get that $25,000 is a matter largely within our own control. The rest, as they say, is gravy.
Remember: A solid gold chamber pot won't serve your needs any better than one made of tin, however luxurious the metal might feel. And if anybody is seriously impressed by your bathroom fixtures, you may feel free to discount his opinion in all other matters of value.
Lest anyone get the impression that I am trying to suggest that economists, industrialists, and investors are wrong for adopting the scarcity frame in their approach to life, let me squelch that thought immediately. People, in general, are not idiots, and, as I've said, there are some very excellent reasons for adopting this frame. That being said, exclusively viewing your world through the frame of scarcity will lead to some very severe distortions in the way we live our lives � the kinds of distortions that drive people to bulldoze the wilderness to claim the rocks beneath it, strive to build casinos in our National Parks, or to blithely deny that the product they are selling kills people even while thousands are dying. On a more individual level, the scarcity frame can drive people to spend their lives at the office rather than with their children; or to live the wretched life of a miser; or to take wild risks in their investments when sane, careful husbandry would serve them better in the long run.
Face it � we've all been warped by avarice to some degree or another. I am simply noting that a sensible investor needs to understand these distinctions before he or she can make any intelligent decisions about the course of his or her investment career. Your life is larger than the size of your wallet, regardless of how large or small your estate happens to be.
I am dismayed that so much of the political discourse in our country is predicated on the assumption that economic values are the only ones that are legitimate, and that free reign ought to be given to those who seek merely to maximize dollar wealth at the expense of all other values, as if money and not men were the measure of all things. We all need to make value judgments, and those decisions often need to be made with regard to matters that are beyond the scope of money.
Just what are you expecting your investments to do for you? When you buy a stock in a company in the hope that the price it will fetch for you tomorrow will be greater than the price you pay today, what of it? You may or may not have answers to that question. I know what my own answers are. I am only looking to increase my opportunities in this already abundant world. I don't expect money to make me smarter or better looking or a more cunning Foosball play or to convince my friends and associates to love me more. I expect that money will free me from the necessity of tending to things the value of which can only be measured in dollars, and allow me to focus more on the places where the real value in life can be found.
Value, at the bottom of all things, is only an idea, and a maddeningly slippery one at that. Value Investors, however, have a pretty good grasp of that idea � and the best ones, I'm convinced, are those who are fully aware of how elusive a concept it can be.
Adventures in Valuation #1
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